The risks to the local currency bond markets in emerging East Asia are rising in view of the tightening liquidity in the corporate bond market in the region and a weaker property market in China that may limit the ability of some of the property companies to service their debt obligations.

In addition, there is also a risk of an earlier-than-expected rate hike in the US that could raise the borrowing costs and lead to the further appreciation of the US dollar.

The latest issue of the Asia Bond Monitor released by the Asian Development Bank (ADB) on November 25 notes that there were concerns that liquidity conditions are tightening because the higher capital requirements under the Basel III regulations have pushed banks to reduce their holdings of bonds.

The ADB explains: "The rules are meant to reduce risk-taking by banks. To do this, the capital that banks are required to hold against risky assets, such as the low-rated local currency corporate bonds, has risen significantly. This has had the effect of making the region's local currency corporate bond market less liquid."

Meanwhile, the latest indicators show that the property market is continuing to slow in China. The ADB says that as concerns grow over the property market, small and less creditworthy companies might find access to funds limited and/or more expensive. They might also find it difficult to service their existing borrowings.

There is also concern that the improved economic conditions in the US may cause the Federal Reserve to raise interest rates sooner than expected. "An earlier-than-anticipated monetary tightening could roil the emerging East Asia's financial markets," the ADB says. It likewise warns that an appreciating US dollar could pose a problem for companies that have been issuing foreign currency bonds.

In the first nine months of 2014, a total of US$143 billion in foreign currency-denominated bonds were issued in emerging East Asia, exceeding the US$141.5 billion issued for the whole of 2014.

In terms of currency movements, most of the region's currencies weakened against the US dollar between July and October. The Korean won experienced the largest decline, depreciating 5.7% against the greenback. The Singapore dollar and the Philippine peso depreciated 3.2% and 2.9%, respectively. In contrast, China and Vietnam saw the value of their currencies strengthened 1.4% and 0.2%.

Amid this trend and risks looming in the horizon, the local currency bond markets in emerging East Asia continued to expand in the third quarter of 2014, reaching US$8.2 trillion as at the end of September. The government bond markets accounted for about 60% of the total at US$4.9 trillion, representing an increase of 3.2% quarter-on-quarter and 11.3% year-on-year.

On the other hand, the corporate bonds outstanding reached US$3.3 trillion at the end of September, manifesting a growth rate of 2.9% from the previous quarter and 11.3% from a year ago.

China's bond market remained the largest in emerging East Asia in the third quarter of 2014, accounting for 63% of the total market at over US$5.1 billion, followed by South Korea with US$1.7 trillion and Malaysia with US$329 billion.